The way in which your business grows, pays tax, takes big decisions and deals with liabilities will depend on its legal structure. This is something you decide at the outset, but can change later on if it becomes desirable. There are four popular types of business structure.
The different types of business structure:
- Sole Trader
- Limited Company (Ltd)
- Limited Liability Partnership (LLP)
All of these business structures have advantages and disadvantages, depending on factors such as the size of your business, the nature of your business and your future plans for it. Here’s a quick summary of each type of business structure, and how they compare against each other.
Sole Trader (‘self-employed’)
Being a sole trader is often referred to simply as being ‘self-employed’, though there are other forms of self-employment (such as being a contractor). Sole trader is the most popular structure for a startup, and also the simplest. You pay income tax on your profits (rather than corporation tax), so any profits above £45,001 will be taxed at 40 per cent, and profits above £150,000 will be taxed at 45 per cent (these rates are applicable in UK). Depending on your profits, you may also have to pay National Insurance (NI) contributions.
Being a sole trader doesn’t necessarily mean you work alone. You can employ staff, so long as you inform HMRC and follow employment law.
Advantages of being a Sole Trader
As a sole trader you pay no fees to register, you have very little red tape, and you are in full control of business decisions. You also get to keep all the profits from the business, after tax.
Disadvantages of being a Sole Trader
The main drawback is that your business and personal finances are not legally separate. This means that, if the business has debts or is sued, any liability can be met from your personal wealth. This exposes you to more personal risk than other business structures, so may not be suitable for a high-cost startup.
Summary: A simple and agile structure, but with a lot of personal risk.
In a partnership, a number of individuals sign a partnership agreement to establish how the business’s ownership, profits and liabilities are shared between them, and how partners may leave the partnership. A partnership is similar to the sole trader structure, except that there are at least two of you. There is no legal upper limit to the number of partners, though very large partnerships can be riskier to manage (see Limited Liability Partnerships). Each partner registers as self-employed and submits a separate tax return. Your tax and NI obligations are similar to those of a sole trader.
Advantages of a Partnership
The advantages of a partnership are flexibility and simplicity, with the added bonus of having more owners to run the business.
Disadvantages of a Partnership
In a partnership, all partners are jointly responsible for all the business debts. This means for instance that if one partner is sued successfully, all partners must share the damages.
Summary: A streamlined setup for business partners who know and trust each other well.
Incorporating your business as a Limited Company requires you to register it at Companies House (for UK citizen). This creates a separate legal entity, which is your company.
Advantages of a Limited Company
The main advantage of setting up a limited company is that its finances are separate from yours. This reduces your personal exposure to financial risk, so if the business fails (or is sued) then you are liable only for the face value of your share in the business.
Another big advantage is the tax regime: companies pay corporation tax at 19 per cent on their profits. This can be significantly more tax-efficient than paying income tax on income, especially for higher-rate taxpayers (though as a director you will still have to find a way to take income from the company, such as salary or dividends, which will be taxed accordingly).
Disadvantages of a Limited Company
One downside is that a Limited Company involves much more administration. You are likely to need a company secretary and very probably an accountant too (though you can outsource both of these roles). You must submit an annual company tax return and full statutory accounts to HMRC, and are responsible for paying employees’ income tax and NI contributions too.
Summary: Good for the maturing business that is ready to trade agility for greater stability.
Contractors – Your own company, or an Umbrella Company?
If you are a contractor, you will most likely want to set up a Limited Company of one person, or else join an umbrella company. Sole trader contractors are rare, as clients and agencies face the issue of whether or not the contractor counts as an employee for legal purposes.
Limited Liability Partnership
A Limited Liability Partnership (LLP) is a popular structure for professional services such as accountancy and legal firms. In most respects they are similar to ordinary partnerships (see above) but as the name implies they have limited liability (like a Limited Company). An LLP must be registered at Companies House (for UK citizen), and at least two partners must be ‘designated members’ who take responsibility for filing the annual accounts.
Advantages of an LLP
As with an Ordinary Partnership, each partner in an LLP registers as self-employed and submits a separate tax return. But if the business fails, each partner is only liable for the face value of his or her share.
Disadvantages of an LLP
The administrative burden of an LLP is similar to that of a Limited Company, so an accountant and company secretary may be desirable (though not required by law).
Summary: A sensible step for partnerships above a certain size.
Comparing different business structures
Here you can compare the different business structures side by side and see the main strengths and weaknesses of each.
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Ask your accountant about the most suitable structure for your business at its current stage of development.
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